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Dimon-Buffett plan to drop guidance could cause investors to rely on 'rumor and innuendo,' analyst Bove says

  • Jamie Dimon and Warren Buffett put forth a plan to stop companies from putting out quarterly guidance.
  • While the idea was well-received in some quarters, banking analyst Dick Bove said doing so would be "misguided" and hurt investors.
  • Bove said investors would have less access to information, making markets even more speculative and volatile.

A proposal by Jamie Dimon and Warren Buffett to end quarterly earnings guidance drew considerable acclaim but also scattered criticism, including a sharp rebuke from an analyst who's been in the business for more than half a century.

The idea is "misguided" in that it would increase market volatility by reducing information and actually increasing speculation, said Dick Bove, a strategist at Hilton Capital Management, who has been a widely followed and sometimes contrarian voice in the financial markets since 1965.

"We're driving the market on rumor and innuendo, we're driving the market to high-velocity trading, we're driving it in all these directions that say knowledge has no value," Bove said in an interview. "These two guys are at the top of the list saying knowledge has no value, therefore we don't want to give it to you."

Dimon, who runs the largest bank in the U.S. as J.P. Morgan Chase CEO, and Buffett, the legendary head of industrial conglomerate Berkshire Hathaway, rocked Wall Street with their suggestion that corporate executives should stop providing future profit estimates during quarterly earnings presentations.

In a Wall Street Journal op-ed Thursday, and a joint CNBC interview, the duo bemoaned the short-term thinking plaguing market activity.

"In our experience, quarterly earnings guidance often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability," they wrote.

J.P. Morgan representatives did not respond to a request for further comment on Bove's remarks. A Berkshire spokesman pointed to a portion of the op-ed noting that "transparency about financial and operating results is an essential aspect of U.S. markets" and advocates for quarterly reporting to continue, minus the forward-looking aspect.

Dimon and Buffett are hardly the only business leaders who have criticized the increasing trend in markets to look for fast gains over sound long-term investing. Vanguard founder Jack Bogle has frequently worried about investors who aren't interested in the long-range prospects for companies in which they put their money, a concern that pushed him into pioneering the first mutual funds that followed indexes rather than individual companies.

Dick Bove
Jin Lee | Bloomberg | Getty Images
Dick Bove

However, Bove feels that anything limiting information flow will only add to market instability.

"What you're suggesting is analysts take multiple sources, none of which are solid in terms of information flow, and make guesses to what's going on in the company [with information from] third-party sources," he said. "Historically, we know that leads to a lot of misinformation, a lot of rumor-mongering, and, in my view, a lot of volatility."

The information analysts get from company executives, though, isn't always so reliable either.

Since 2007, which includes the financial crisis years, corporate earnings guidance was lower than actual results seven times and higher four times, according to FactSet. The average underestimation of profits was 4.02 percent, while the average overestimation was 2.74 percent. Overall, company officials typically underestimated profits by 1.57 percent.

(The chart below looks at the history of guidance versus results. The "harmonic average" weeds out companies that had outsized profit declines.)

Earnings results compared to guidance since 2007

Click to edit
Click to edit
Guidance
Actual
Surprise %
2007 Average 2.5941 2.3433 -3.6386%
Harmonic Average 1.2687 1.2842 -0.0041%
2008 Average 2.5226 2.4579 -3.7125%
Harmonic Average 1.5390 1.5686 -0.0021%
2009 Average 2.412 2.412 6.9366%
Harmonic Average 1.753 1.758 -0.0015%
2010 Average 2.642 2.671 3.3051%
Harmonic Average 1.232 1.569 0.0026%
2011 Average 2.9670 3.0402 4.3986%
Harmonic Average 3.0593 7.4407 1.4042%
2012 Average 3.1817 3.1801 -3.5123%
Harmonic Average 1.7872 2.4546 0.0019%
2013 Average 3.50130 3.52050 0.9165%
Harmonic Average -3.1036 13.6883 -0.0021%
2014 Average 3.8626 3.9383 10.3637%
Harmonic Average 2.3340 2.6384 1.6778%
2015 Average 4.1035 4.0933 0.1515%
Harmonic Average 2.7553 2.8498 0.0023%
2016 Average 4.4619 4.4990 2.0698%
Harmonic Average 3.0765 3.1785 -0.0026%
2017 Average 4.7978 4.7893 -0.1219%
Harmonic Average 2.9692 3.0196 -0.0017%
Source: FactSet

In reality, getting rid of these forecasts completely is unlikely. As Bove said, Wall Street feasts on information, so implementing such a plan would be problematic on a variety of levels.

For one thing, if some companies provided outlooks and others didn't, the ones who simply presented earnings numbers might come under suspicion that they were hiding something. For another, investors themselves likely would recoil and push companies to provide more information.

"You've got two very smart guys saying this is the smart way to go. I think everyone in the abstract agrees," said Nick Colas, co-founder of DataTrek Research and a former auto industry analyst. "But the cat's out of the bag. You're not putting this one back in."

That doesn't mean there won't be some move toward getting the market to change its focus. With Buffett and Dimon lending their names to the cause, action is sure to follow in some form.

Sell-side analysts have been taking heat for years. With the switch going from stock picking to the passive strategies that ETFs follow indexes, their research has become in less demand and fees have been pushed sharply lower in many cases.

Cutting them off from a flow of information would be another shot at the group.

"When you give guidance, you're just feeding the estimate frenzy. It's always wrong," said Christopher Whalen, head of Whalen Global Advisors, which provides investment banking advice. "They play this little game, and I don't think it's helpful to investors."

The market probably, though, will look for something more incremental than eliminating forward guidance.

Despite their lack of accuracy, the statements can at least provide investors with insight into what bigger plans companies have, rather than just the backward-looking numbers that come with quarterly earnings reports.

"It really is the only insight most shareholders get of what's going on inside company walls," said JJ Kinahan, chief market strategist at TD Ameritrade. "For the average person at home, it's tough to get good information from a trusted source. Well, there's usually no more trusted source than the CEO or CFO of a company, and I don't think you can underrate that."

Kinahan thinks there could be a compromise — perhaps changing the forecasts and actual earnings reports to every six months and some type of "state of the union" message from companies still on a quarterly basis.

"The overall point that Mr. Buffett and Mr. Dimon are making is really important. I do agree with them that we spend too much time on a three-month period when it's really the long term we should look at," he said. "How do we come to what they want compared to the needs of investors? There has to be a happier middle ground."

WATCH: Buffett explains the dangers of earnings guidance.